News

Philippe Waechter

Chief economist

Desynchronization ahead for the end of the year

18.10.2018 - Philippe Waechter

The world economy has developed in a less synchronized manner this year in a clear shift away from the 2017 trend, and this greater divergence is reflected in the slower pace of world trade, with a gain of 3.1% in 2018 YTD vs. 4.5% growth on average in 2017. World trade no longer acts as the driving force it was right throughout 2017, suggesting a great influence from domestic economic policy tendencies.

US domestic momentum is poised to continue driving growth for the next 6 to 12 months as a result of the White House’s policies, with very accommodative fiscal policy propping up domestic demand and trade policy channeling this growing demand to US companies. This policy is set against a backdrop of full employment and forces the Fed to take a more restrictive approach to avoid the emergence of severe imbalances in the country, especially in terms of inflation. We are set to see the Fed maintain this approach through 2019, as it continues to curb imbalances by dampening economic activity – which is currently expanding at a faster pace than potential growth – rather than allowing severe divergences to emerge that would be difficult to manage in the longer term. Tighter monetary policy will then push the yield curve flatter as this restrictive approach sets the stage for a dip in economic activity i.e. the 10 year- 2 year spread sliding into negative territory has traditionally been a strong signal in the post-war period. This shift, which we imagine will be limited, will particularly involve real estate.

Dollar set to stay strong
Recent tighter policy in China came hot on the heels of significant accommodation last year. The government’s very clear-cut growth steering strategy has been effective, but is no longer fueling a strong and sustainable acceleration in growth, while we also note that China’s arm is not quite so long and its influence on world growth has weakened.

Meanwhile in the euro area, growth is poised to be more sluggish this year than last, and this trend is not about to change in 2019 either. Growth hit a peak in late 2017 and is now set on a path towards its potential rate, but this must not be a cue for the ECB to swiftly toughen its stance, particularly as inflation forecasts are flat. The domestic arena must provide a source of impetus when the rest of the world fails to drive growth, yet the policy mix is only moderately accommodative i.e. not much fiscal accommodation but continued monetary accommodation, which is not enough to offset the trend towards potential growth.

This worldwide balance and the various related monetary policies are paving the way for a continued strong – or even stronger – dollar, at the expense of emerging markets that have been suffering from the greenback’s surge since April, and especially countries that carry high dollar-denominated debt, such as Turkey, Argentina and South Africa.

Continued risks on worldwide momentum
A number of risks remain: the first is a continued rise in oil prices, which have been higher since the start of the year as a result of stronger demand. Meanwhile, US sanctions, especially on Iran, have pushed prices up further since the Spring, as oil-producing countries do not want to offset the shortages triggered by the cut in Iran’s production, so Brent has soared above the $80/bbl mark as a result. This stance from producers could create an uptrend for prices despite record US production, which would hamper purchasing power across all western countries.

The second risk is a potential failure of Brexit negotiations, as the United Kingdom and the European Union must come to an agreement within the next two months to avoid the UK crashing out of the EU with no deal, but an accord is looking increasingly unlikely.

Meanwhile, the situation in the US could change after the midterm elections on November 6: a Republican defeat could cast doubt over the scenario we outlined above, particularly on the dollar’s rise, and Donald Trump would no longer be shored up by Congress and have the same influence on the rest of the world.

The fourth risk lies in Italy and how the budget question pans out.

Lastly, the fifth risk is the White House’s trade war, which is slightly fettering world trade for now and is beginning to affect the American population as companies and consumers in the country are bearing the cost of these moves for the moment.

Philippe Waechter is Head of the economic research department of Ostrum Asset Management.

Philippe joined Bred Banque Populaire in April 1988 as an economist. In 1994 he became Director of the economic research department. When Banque Populaire Asset Management was created in June 1998 (which then became Natexis Asset Management in May 2003) Philippe held the same position.

Philippe is graduated from the University of Paris I and worked as a Professor at the University of Evry from 2002 to 2003. He regularly works for the print and audiovisual media.